5 Key Reps and Warranties Considerations in Maintaining and Closing a Deal

Here are five reps and warranties coverage considerations when maintaining and closing a deal.
By: | September 20, 2021
Topics: M&A

When closing an M&A deal, it’s imperative for both buyer and seller to emerge with all of their bases covered. With the presence of reps and warranties coverage, all parties involved will remain protected, should a breach occur.

Reps and warranties coverage presents a product that supplements traditional seller indemnity by covering losses that are produced from a breach. Additionally, if a deal unexpectedly dissipates, reps and warranties coverage ensures that the buyer will remain whole and the seller will be able to make a clean exit from the transaction.

While incredibly beneficial, “reps and warranties is an elegant solution to some of the more challenging negotiation points in an M&A transaction,” said Aaron Zeid, area senior vice president, Gallagher.

Because of their complicated nature, several considerations need to be kept in mind when it comes to reps and warranties. Here are five key points that every professional should consider when closing a deal.

1) It’s All About the Due Diligence Process

When it comes to a reps and warranties presence in a deal closing, there is a strong dependence on the due diligence process.

Zeid stressed the importance of due diligence, saying that the reps and warranties process is “essentially diligence on the buyer’s due diligence.”

Zeid also said that the buyer must be able to substantiate the accuracy of the seller’s reps and warranties in the underlying purchase agreement. This becomes important when determining and identifying the key considerations of a deal.

Engaging the correct professionals as due diligence advisors, which include legal counsel, financial tax advisors, environmental insurance, benefits and so on, is critical. The specific players can change depending on the nature of the deal, but legal, tax and financial advisors should play key roles.

2) Timing Is Everything

The M&A market is currently experiencing an environment where deal volume is high.

Zeid explained that the RWI process occurs in two phases: first, obtaining non-binding indications by providing relevant submission materials, including a draft purchase agreement, CIM and target financials; and second, formal underwriting, which can begin once the buyer is able to share diligence materials with the insurer.

Because the market is handling a large volume of deals, brokers should be brought into the process as soon as possible. From a reps and warranties standpoint, carriers need to review all diligence processes which include ensuring that information is true and accurate. Usually after this is when the brokering and underwriting processes begin.

Zeid also stressed the need for brokers earlier than typical as we approach fourth quarter, where carriers can be selective in terms of what they want to underwrite. In some cases, carriers and brokers will choose to refrain from underwriting under a tight timeline.

“The earlier you can reach out to your broker and start discussing coverage options, the better,” Zeid said.

3) Reps and Warranties Is Not a Substitute for Other Commercially Available Insurance 

While reps and warranties coverage is a valuable asset, it does not serve as an alternative option for other commercial availability insurance policies. Rather, reps and warranties is an additive to the already present coverage.

This commercial insurance coverage will vary depending on the nature of the deal or the target risks that need to be addressed. These target risks could include professional liability for a business, or environmental concerns for a manufacturer.

To properly engage in the due diligence process, insurance advisors need to properly identify any underlying target risks in the coverage.

Reps and warranties cannot always protect from any potential risks or holes within the policy itself, so it’s imperative to ensure that there is still adequate coverage along with reps and warranties before closing.

4) There Is Benefit to Collaborating with Outside Sources

To successfully close on a reps and warranties deal, carriers and brokers must be able to get comfortable covering certain risks and liabilities.

 Zeid mentioned tax liability and contingent liability insurance as two transactional risk products that potential insureds familiarize themselves with as there is growing appetite to insure against these known tax and contingent exposures that are often carved out from RWI coverage.
In order for a carrier to get comfortable covering these known risks, insurers rely on analysis from outside advisors, such as legal and tax counsel, that can demonstrate that the likelihood of the risk materializing is low.

 

5) Get Comfortable with the Product

Reps and warranties coverage in an M&A deal has become an industry norm. It’s likely to remain a staple component of deal closing for years to come.

Because of this, it’s important for M&A professionals to become familiar with reps and warranties and its capabilities.

In a market that’s experiencing high deal volume and pricing, reps and warranties coverage is going to be crucial in securing a peaceful transaction. If carriers are not accustomed to reps and warranties coverage, it’ll be a challenge to secure and close a deal. &

Emma Brenner is a staff writer with Risk & Insurance. She can be reached at [email protected]

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